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The value of interest rate stabilization polices when agents are learning

John Duffy () and Wei Xiao ()

No 2004-02, Working Papers from University of New Orleans, Department of Economics and Finance

Abstract: We examine the expectational stability (E—stability) of rational expectations equilibrium under optimal interest rate rules in the context of the standard, “New Keynesian” model of the monetary transmission mechanism. We focus on the case where the monetary authority adds interest rate stabilization to its other objectives of inflation and output stabilization. We consider both the case where the monetary authority lacks a commitment technology and as well as the case of full commitment. We show that for both cases, optimal interest rate rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. This finding stands in contrast to the findings of Evans and Honkapohja (2002, 2003ab) for optimal monetary policy rules in environments where interest rate stabilization is not part of the central bank’s objective function.

Keywords: Expectational stability (E-stability); Rational expectations equilibrium; Monetary transmission mechanism (search for similar items in EconPapers)
JEL-codes: D83 E43 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-mac
Date: 2004-06
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Journal Article: The Value of Interest Rate Stabilization Policies When Agents Are Learning (2007) Downloads
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